UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014
For the transition period from _______to_______
Commission file number 000-53149
SERVISFIRST BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
(205) 949-0302
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or Section 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes xNo ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer ¨Accelerated filer x Non-accelerated filer ¨Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
TABLE OF CONTENTS
PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2014 AND DECEMBER 31, 2013
(In thousands, except share and per share amounts)
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(In thousands, except share amounts)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
NOTE 1 - GENERAL
The accompanying consolidated financial statements in this report have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, including Regulation S-X and the instructions for Form 10-Q, and have not been audited. These consolidated financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. In the opinion of management, all adjustments necessary to present fairly the consolidated financial position and the consolidated results of operations for the interim periods have been made. All such adjustments are of a normal nature. The consolidated results of operations are not necessarily indicative of the consolidated results of operations which ServisFirst Bancshares, Inc. (the “Company”) may achieve for future interim periods or the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s Form 10-K/A for the year ended December 31, 2013. The Company’s wholly-owned subsidiary, ServisFirst Bank, is referred to herein as the “Bank.”
The Company announced on June 16, 2014 that it declared a three-for-one split of its common stock in the form of a stock dividend. On July 16, 2014, stockholders of record as of the close of business on July 9, 2014, would receive a distribution of two additional shares of ServisFirst common stock for each share they hold. Except where specifically indicated otherwise, all reported amounts in this Form 10-Q are adjusted to give effect to this stock split.
All reported amounts are in thousands except share and per share data.
NOTE 2 - CASH AND CASH EQUIVALENTS
Cash on hand, cash items in process of collection, amounts due from banks, and federal funds sold are included in cash and cash equivalents.
NOTE 3 - EARNINGS PER COMMON SHARE
Basic earnings per common share are computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options and warrants.
NOTE 4 - SECURITIES
The amortized cost and fair value of available-for-sale and held-to-maturity securities at September 30, 2014 and December 31, 2013 are summarized as follows:
The amortized cost and fair value of debt securities as of September 30, 2014 by contractual maturity are shown below. Actual maturities may differ from contractual maturities of mortgage-backed securities since the mortgages underlying the securities may be called or prepaid with or without penalty. Therefore, these securities are not included in the maturity categories along with the other categories of debt securities.
Amortized
Cost
The Company sold one available-for-sale municipal debt security for total proceeds of $173,000 at a gain of $3,000 in the third quarter of 2014. The Company sold two corporate debt securities for total proceeds of $4.1 million and a gain of $131,000 during the first nine months of 2013.
All mortgage-backed securities are with government-sponsored enterprises (GSEs) such as Federal National Mortgage Association, Government National Mortgage Association, Federal Home Loan Bank, and Federal Home Loan Mortgage Corporation.
The following table identifies, as of September 30, 2014 and December 31, 2013, the Company’s investment securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months. At September 30, 2014, 51 of the Company’s 699 debt securities had been in an unrealized loss position for 12 or more months. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell the securities before recovery of their amortized cost, which may be maturity; accordingly, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2014. Further, the Company believes any deterioration in value of its current investment securities is attributable to changes in market interest rates and not credit quality of the issuer.
NOTE 5 – LOANS
The following table details the Company’s loans at September 30, 2014 and December 31, 2013:
The credit quality of the loan portfolio is summarized no less frequently than quarterly using categories similar to the standard asset classification system used by the federal banking agencies. The following table presents credit quality indicators for the loan loss portfolio segments and classes. These categories are utilized to develop the associated allowance for loan losses using historical losses adjusted for current economic conditions defined as follows:
Loans by credit quality indicator as of September 30, 2014 and December 31, 2013 were as follows:
Loans by performance status as of September 30, 2014 and December 31, 2013 were as follows:
Loans by past due status as of September 30, 2014 and December 31, 2013 were as follows:
The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions and other risks inherent in the portfolio. Allowances for impaired loans are generally determined based on collateral values or the present value of the estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for losses on loans. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.
The methodology utilized for the calculation of the allowance for loan losses is divided into four distinct categories. Those categories include allowances for non-impaired loans (ASC 450), impaired loans (ASC 310), external qualitative factors, and internal qualitative factors. A description of each category of the allowance for loan loss methodology is listed below.
Non-Impaired Loans. Non-impaired loans are grouped into homogeneous loan pools by loan type and are the following: commercial and industrial, construction and development, commercial real estate, second lien home equity lines of credit, and all other loans. Each loan pool is stratified by internal risk rating and multiplied by a loss allocation percentage derived from the loan pool historical loss rate. The historical loss rate is based on an age weighted 5 year history of net charge-offs experienced by pool, with the most recent net charge-off experience given a greater weighting. This results in the expected loss rate per year, adjusted by a qualitative adjustment factor and a years-to-impairment factor, for each pool of loans to derive the total amount of allowance for non-impaired loans.
Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the original terms of the loan agreement. The collection of all amounts due according to contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, at the loan’s observable market price or the fair value of the underlying collateral. The fair value of collateral, reduced by costs to sell on a discounted basis, is used if a loan is collateral-dependent. Fair value estimates for specifically impaired collateral-dependent loans are derived from appraised values based on the current market value or “as is” value of the property, normally from recently received and reviewed appraisals. Appraisals are obtained from certified and licensed appraisers and are based on certain assumptions, which may include construction or development status and the highest and best use of the property. These appraisals are reviewed by our credit administration department, and values are adjusted downward to reflect anticipated disposition costs. Once this estimated net realizable value has been determined, the value used in the impairment assessment is updated for each impaired loan. As subsequent events dictate and estimated net realizable values decline, required reserves may be established or further adjustments recorded.
External Qualitative Factors . The determination of the portion of the allowance for loan losses relating to external qualitative factors is based on consideration of the following factors: gross domestic product growth rate, changes in prime rate, delinquency trends, peer delinquency trends, year over year loan growth and state unemployment rate trends. Data for the three most recent periods is utilized in the calculation for each external qualitative component. The factors have a consistent weighted methodology to calculate the amount of allowance due to external qualitative factors.
Internal Qualitative Factors . The determination of the portion of the allowance for loan losses relating to internal qualitative factors is based on the consideration of criteria which includes the following: number of extensions and deferrals, single pay and interest only loans, current financial information, credit concentrations and risk grade accuracy. A self-assessment for each of the criteria is made with a consistent weighted methodology used to calculate the amount of allowance required for internal qualitative factors.
In the third quarter of 2014, the allowance for loan loss calculation was updated to incorporate a greater emphasis placed on external and internal qualitative factors compared to historical calculations. This was determined based on an analysis of loan growth, loss rates relative to peer institutions and overall interest rate risk. This adjustment increased the allowance for loan losses associated with external and internal qualitative factors by $2.1 million at September 30, 2014 compared to June 30, 2014.
The following table presents an analysis of the allowance for loan losses by portfolio segment as of September 30, 2014 and December 31, 2013. The total allowance for loan losses is disaggregated into those amounts associated with loans individually evaluated and those associated with loans collectively evaluated.
The following table presents details of the Company’s impaired loans as of September 30, 2014 and December 31, 2013, respectively. Loans which have been fully charged off do not appear in the tables.
December 31, 2013
Troubled Debt Restructurings (“TDR”) at September 30, 2014, December 31, 2013 and September 30, 2013 totaled $7.9 million, $ 14.2 million and $8.4 million, respectively. At September 30, 2014, the Company had a related allowance for loan losses of $1.9 million allocated to these TDRs, compared to $2.4 million at December 31, 2013 and $0.8 million at September 30, 2013. The Company’s TDRs for the three and nine months ended September 30, 2014 and 2013 have all resulted from term extensions rather than from interest rate reductions or debt forgiveness. The following tables present loans modified in a TDR during the periods presented by portfolio segment and the financial impact of those modifications. The tables include modifications made to new TDRs, as well as renewals of existing TDRs.
The following table presents TDRs by portfolio segment which defaulted during the three and nine months ended September 30, 2014 and 2013, and which were modified in the previous twelve months (i.e., the twelve months prior to default). For purposes of this disclosure default is defined as 90 days past due and still accruing or placement on nonaccrual status.
NOTE 6 - EMPLOYEE AND DIRECTOR BENEFITS
Stock Options
At September 30, 2014, the Company had stock-based compensation plans, as described below. The compensation cost that has been charged to earnings for the plans was approximately $302,000 and $3.4 million for the three and nine months ended September 30, 2014 and $308,000 and $889,000 for the three and nine months ended September 30, 2013. The Company recorded a non-routine expense of $703,000 for the first quarter of 2014 resulting from the correction of its accounting for vested stock options previously granted to members of its advisory boards, and recorded a non-routine expense of $1.8 million for the second quarter of 2014 resulting from an acceleration of vesting of all stock options granted to members of its advisory boards. Such stock options were historically accounted for under the provisions of Accounting Standards Codification (“ASC”) 718-10, Compensation – Stock Compensation, and now have been determined to be recorded as an expense at the fair value of such options in accordance with the provisions of ASC 505-50,Equity-based Payments to Non-employees.
The Company’s 2005 Amended and Restated Stock Option Plan allows for the grant of stock options to purchase up to 3,075,000 shares of the Company’s common stock. The Company’s 2009 Amended and Restated Stock Incentive Plan authorizes the grant of up to 2,775,000 shares and allows for the issuance of Stock Appreciation Rights, Restricted Stock, Stock Options, Non-stock Share Equivalents, Performance Shares or Performance Units. In June 2014, the Company amended the 2009 Plan to allow for an additional 1,500,000 shares. Both plans allow for the grant of incentive stock options and non-qualified stock options, and awards are generally granted with an exercise price equal to the estimated fair market value of the Company’s common stock at the date of grant. The maximum term of the options granted under the plans is ten years.
The Company has granted non-plan options to certain persons representing key business relationships to purchase up to an aggregate amount of 165,000 shares of the Company’s common stock at prices between $5.00 and $6.67 per share with a term of ten years. These options are non-qualified and not part of either plan.
The Company estimates the fair value of each stock option award using a Black-Scholes-Merton valuation model that uses the assumptions noted in the following table. Expected volatilities are based on an index of southeastern United States publicly traded banks. The expected term for options granted is based on the short-cut method and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U. S. Treasury yield curve in effect at the time of grant.
The weighted average grant-date fair value of options granted during the nine months ended September 30, 2014 and September 30, 2013 was $2.95 and $2.68, respectively.
The following table summarizes stock option activity during the nine months ended September 30, 2014 and September 30, 2013:
As of September 30, 2014, there was approximately $1.5 million of total unrecognized compensation cost related to non-vested stock options. The cost is expected to be recognized on the straight-line method over the next 1.6 years.
Restricted Stock
The Company has issued 235,500 shares of restricted stock to certain employees. The value of restricted stock awards is determined to be the current value of the Company’s stock, and this total value will be recognized as compensation expense over the vesting period. As of September 30, 2014, there was $990,000 of total unrecognized compensation cost related to non-vested restricted stock. The cost is expected to be recognized evenly over the remaining 1.3 years of the restricted stock’s vesting period.
Stock Warrants
The Company granted warrants for 45,000 shares of common stock of the Company with an exercise price of $8.33 per share in the second quarter of 2009. These warrants were granted in connection with the issuance of the Company’s 8.25% Subordinated Note due June 1, 2016. All of these warrants were exercised during the second quarter of 2014.
NOTE 7 - DERIVATIVES
The Company has entered into agreements with secondary market investors to deliver loans on a “best efforts delivery” basis. When a rate is committed to a borrower, it is based on the best price that day and locked with the investor for the customer for a 30-day period. In the event the loan is not delivered to the investor, the Company has no risk or exposure with the investor. The interest rate lock commitments related to loans that are originated for later sale are classified as derivatives. The fair values of the Company’s agreements with investors and rate lock commitments to customers as of September 30, 2014 and December 31, 2013 were not material.
NOTE 8 – RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In July 2013, the FASB issued ASU No. 2013-10, Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes, which permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to the U.S. Treasury and London Interbank Offered Rate. The ASU also amends previous rules by removing the restriction on using different benchmark rates for similar hedges. This amendment applies to all entities that elect to apply hedge accounting of the benchmark interest rate. The amendments in this ASU were effective for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The Company has adopted this update, but such adoption had no impact on its financial position or results of operations.
In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which provides that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. These amendments in this ASU are effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2013. Early adoption and retrospective application is permitted. The Company has adopted this update, but such adoption had no impact on its financial position or results of operations.
In January 2014, the FASB issued ASU No. 2014-1, Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects, which provides guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. It permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial investment in proportion to the tax credits and other tax benefits received, and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for public entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014, and are effective for all entities other than public entities for annual periods beginning after December 15, 2014, and interim reporting periods within annual periods beginning after December 15, 2015. Early adoption is permitted and retrospective application is required for all periods presented. The Company made an investment in a limited partnership during the first quarter of 2014 which has invested in a qualified affordable housing project. The Company has made an election to account for this investment as provided for in this update, and will recognize the net investment performance of its share of the partnership as tax credits become available.
NOTE 9 - RECENT ACCOUNTING PRONOUNCEMENTS
In January 2014, the FASB issued ASU No. 2014-04, Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. These amendments are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. The amendments clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) the creditor obtaining legal title to the residential real estate property upon completion of residential foreclosure, or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additional disclosures about such activities are required by these amendments. The amendments in this ASU become effective for public companies for annual periods and interim periods within those annual periods beginning after December 15, 2014, and early adoption is permitted. The Company is assessing the impact that these amendments will have on its financial position and results of operations, but does not currently anticipate that it will have a material impact.
In May 2014, the FASB issued ASU No. 2014-09,Revenue from Contracts with Customers (Topic 606). These amendments affect any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g. insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance, and creates a Topic 606, Revenue from Contracts with Customers. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This ASU will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The ASU allows for either full retrospective or modified retrospective adoption. The Company is assessing the effects of this ASU, which exclude financial instruments from its scope, but does not anticipate that it will have a material impact on its financial position or results of operations.
In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. The amendments clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. None of the Company’s share-based payment awards have service components, so the Company does not believe this ASU will have an impact on its financial position or results of operations.
In August 2014, the FASB issued ASU No. 2014-14 – Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. These amendments address the diversity in practice regarding the classification and measurement of foreclosed loans which were part of a government-sponsored loan guarantee program (e.g. HUD, FHA, VA). The ASU outlines certain criteria that, if met, the loan (residential or commercial) should be derecognized and a separate other receivable should be recorded upon foreclosure at the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. This ASU will be effective for annual reporting periods beginning after December 15, 2014, including interim periods within that reporting period. Early adoption is permitted, provided the entity has adopted ASU 2014-04. The ASU should be adopted either prospectively or on a modified retrospective basis. The Company is assessing the impact that these amendments will have on its financial position and results of operations, but does not currently anticipate that it will have a material impact.
In August 2014, the FASB issued ASU No. 2014-15 Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. These amendments are intended to reduce diversity in the timing and content of going concern disclosures. This ASU clarifies management’s responsibility to evaluate and provide related disclosures if there are any conditions or events, as a whole, that raise substantial doubt about the entity’s ability to continue as a going concern for one year after the date the financial statements are issued (or, if applicable, available to be issued). The amendments in this ASU are effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. Early application is permitted. The Company does not believe this ASU will have an impact on its financial position or results of operations.
NOTE 10 - FAIR VALUE MEASUREMENT
Measurement of fair value under U.S. GAAP establishes a hierarchy that prioritizes observable and unobservable inputs used to measure fair value, as of the measurement date, into three broad levels, which are described below:
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and also considers counterparty credit risk in its assessment of fair value.
Debt Securities. Where quoted prices are available in an active market, securities are classified within Level 1 of the hierarchy. Level 1 securities include highly liquid government securities such as U.S. Treasuries and exchange-traded equity securities. For securities traded in secondary markets for which quoted market prices are not available, the Company generally relies on pricing services provided by independent vendors. Such independent pricing services are to advise the Company on the carrying value of the securities available for sale portfolio. As part of the Company’s procedures, the price provided from the service is evaluated for reasonableness given market changes. When a questionable price exists, the Company investigates further to determine if the price is valid. If needed, other market participants may be utilized to determine the correct fair value. The Company has also reviewed and confirmed its determinations in discussions with the pricing source regarding their methods of price discovery. Securities measured with these techniques are classified within Level 2 of the hierarchy and often involve using quoted market prices for similar securities, pricing models or discounted cash flow calculations using inputs observable in the market where available. Examples include U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In cases where Level 1 or Level 2 inputs are not available, securities are classified in Level 3 of the hierarchy.
Impaired Loans. Impaired loans are measured and reported at fair value when full payment under the loan terms is not probable. Impaired loans are carried at the present value of expected future cash flows using the loan’s existing rate in a discounted cash flow calculation, or the fair value of the collateral if the loan is collateral-dependent. Expected cash flows are based on internal inputs reflecting expected default rates on contractual cash flows. This method of estimating fair value does not incorporate the exit-price concept of fair value described in ASC 820-10 and would generally result in a higher value than the exit-price approach. For loans measured using the estimated fair value of collateral less costs to sell, fair value is generally determined based on appraisals performed by certified and licensed appraisers using inputs such as absorption rates, capitalization rates and market comparables, adjusted for estimated costs to sell. Management modifies the appraised values, if needed, to take into account recent developments in the market or other factors, such as changes in absorption rates or market conditions from the time of valuation, and anticipated sales values considering management’s plans for disposition. Such modifications to the appraised values could result in lower valuations of such collateral. Estimated costs to sell are based on current amounts of disposal costs for similar assets. These measurements are classified as Level 3 within the valuation hierarchy. Impaired loans are subject to nonrecurring fair value adjustment upon initial recognition or subsequent impairment. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly based on the same factors identified above. The amount recognized as an impairment charge related to impaired loans that are measured at fair value on a nonrecurring basis was $724,000 and $4.3 million during the three and nine months ended September 30, 2014, respectively, and $2.3 million and $8.0 million during the three and nine months ended September 30, 2013, respectively.
Other Real Estate Owned. Other real estate assets (“OREO”) acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at the lower of cost or fair value, less selling costs. Any write-downs to fair value at the time of transfer to OREO are charged to the allowance for loan losses subsequent to foreclosure. Values are derived from appraisals of underlying collateral and discounted cash flow analysis. Appraisals are performed by certified and licensed appraisers. Subsequent to foreclosure, valuations are updated periodically and assets are marked to current fair value, not to exceed the new cost basis. In the determination of fair value subsequent to foreclosure, management also considers other factors or recent developments, such as changes in absorption rates and market conditions from the time of valuation, and anticipated sales values considering management’s plans for disposition, which could result in adjustment to lower the property value estimates indicated in the appraisals. These measurements are classified as Level 3 within the valuation hierarchy. A loss on the sale and write-downs of OREO of $225,000 and $757,000 was recognized for the three and nine months ended September 30, 2014, respectively, and $302,000 and $813,000 for the three and nine months ended September 30, 2013, respectively. These charges were for write-downs in the value of OREO subsequent to foreclosure and losses on the disposal of OREO. OREO is classified within Level 3 of the hierarchy.
The following table presents the Company’s financial assets and financial liabilities carried at fair value on a recurring basis as of September 30, 2014 and December 31, 2013:
The following table presents the Company’s financial assets and financial liabilities carried at fair value on a nonrecurring basis as of September 30, 2014 and December 31, 2013:
The fair value of a financial instrument is the current amount that would be exchanged in a sale between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Current U.S. GAAP excludes certain financial instruments and all nonfinancial instruments from its fair value disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the statements of financial condition approximate those assets’ fair values.
Debt securities: Where quoted prices are available in an active market, securities are classified within Level 1 of the hierarchy. Level 1 securities include highly liquid government securities such as U.S. treasuries and exchange-traded equity securities. For securities traded in secondary markets for which quoted market prices are not available, the Company generally relies on prices obtained from independent vendors. Such independent pricing services are to advise the Company on the carrying value of the securities available for sale portfolio. As part of the Company’s procedures, the price provided from the service is evaluated for reasonableness given market changes. When a questionable price exists, the Company investigates further to determine if the price is valid. If needed, other market participants may be utilized to determine the correct fair value. The Company has also reviewed and confirmed its determinations in discussions with the pricing service regarding their methods of price discovery. Securities measured with these techniques are classified within Level 2 of the hierarchy and often involve using quoted market prices for similar securities, pricing models or discounted cash flow calculations using inputs observable in the market where available. Examples include U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions, and certain corporate, asset-backed and other securities. In cases where Level 1 or Level 2 inputs are not available, securities are classified in Level 3 of the fair value hierarchy.
Restricted equity securities: Fair values for other investments are considered to be their cost as they are redeemed at par value.
Loans, net: For variable-rate loans that re-price frequently and with no significant change in credit risk, fair value is based on carrying amounts. The fair value of other loans (for example, fixed-rate commercial real estate loans, mortgage loans and industrial loans) is estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The method of estimating fair value does not incorporate the exit-price concept of fair value as prescribed by ASC 820 and generally produces a higher value than an exit-price approach. The measurement of the fair value of loans is classified within Level 3 of the fair value hierarchy.
Mortgage loans held for sale: Loans are committed to be delivered to investors on a “best efforts delivery” basis within 30 days of origination. Due to this short turn-around time, the carrying amounts of the Company’s agreements approximate their fair values.
Accrued interest and dividends receivable:The carrying amounts in the statements of condition approximate these assets’ fair value.
Bank owned life insurance contracts:The carrying amounts in the statements of condition approximate these assets’ fair value.
Deposits: The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation using interest rates currently offered for deposits with similar remaining maturities. The fair value of the Company’s time deposits do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value. Measurements of the fair value of certificates of deposit are classified within Level 2 of the fair value hierarchy.
Other borrowings: The fair values of other borrowings are estimated using a discounted cash flow analysis, based on interest rates currently being offered on the best alternative debt available at the measurement date. These measurements are classified as Level 2 in the fair value hierarchy.
Accrued interest payable: The carrying amounts in the statements of condition approximate these assets’ fair value.
Loan commitments: The fair values of the Company’s off-balance-sheet financial instruments are based on fees currently charged to enter into similar agreements. Since the majority of the Company’s other off-balance-sheet financial instruments consists of non-fee-producing, variable-rate commitments, the Company has determined they do not have a distinguishable fair value.
The carrying amount, estimated fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of September 30, 2014 and December 31, 2013 are presented in the following table. This table includes those financial assets and liabilities that are not measured and reported at fair value on a recurring basis or nonrecurring basis.
NOTE 11 – SUBSEQUENT EVENTS
The Company has evaluated all subsequent events through the date of this filing to ensure that this Form 10-Q includes appropriate disclosure of events both recognized in the financial statements as of September 30, 2014, and events which occurred subsequent to September 30, 2014 but were not recognized in the financial statements.
On October 20, 2014, the Company executed a definitive agreement and plan of merger (“Agreement’) with Metro Bancshares, Inc., a Georgia corporation (“Metro”), pursuant to which Metro will merge with and into the Company, with the Company as the surviving corporation (the “Merger”).
Under the terms of the Agreement, the Company will issue 636,720 shares of its common stock and pay approximately $22.8 million in cash for all outstanding shares of Metro common stock, subject to certain conditions and potential adjustments. The Agreement has been unanimously approved by the board of directors of each the Company and Metro. Subject to the approval of the Merger by Metro’s common stockholders, regulatory approvals and the satisfaction of customary closing conditions, the parties anticipate completing the Merger in the first quarter of 2015.
More information about this transaction is available in the Company’s press release dated October 20, 2014 and in its Form 8-K filed with the SEC on October 20, 2014.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is designed to provide a better understanding of various factors relating to the results of operations and financial condition of ServisFirst Bancshares, Inc. (the “Company”) and its wholly-owned subsidiary, ServisFirst Bank (the “Bank”). This discussion is intended to supplement and highlight information contained in the accompanying unaudited consolidated financial statements as of September 30, 2014 and for the three and nine months ended September 30, 2014 and September 30, 2013.
Forward-Looking Statements
Statements in this document that are not historical facts, including, but not limited to, statements concerning future operations, results or performance, are hereby identified as “forward-looking statements” for the purpose of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. The words “believe,” “expect,” “anticipate,” “project,” “plan,” “intend,” “will,” “would,” “might” and similar expressions often signify forward-looking statements. Such statements involve inherent risks and uncertainties. The Company cautions that such forward-looking statements, wherever they occur in this quarterly report or in other statements attributable to the Company, are necessarily estimates reflecting the judgment of the Company’s senior management and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Such forward-looking statements should, therefore, be considered in light of various factors that could affect the accuracy of such forward-looking statements, including: general economic conditions, especially in the credit markets and in the Southeast; the performance of the capital markets; changes in interest rates, yield curves and interest rate spread relationships; changes in accounting and tax principles, policies or guidelines; changes in legislation or regulatory requirements; changes in our loan portfolio and the deposit base; possible changes in laws and regulations and governmental monetary and fiscal policies, including, but not limited to, economic stimulus initiatives; the cost and other effects of legal and administrative cases and similar contingencies; possible changes in the creditworthiness of customers and the possible impairment of the collectability of loans and the value of collateral; the effect of natural disasters, such as hurricanes and tornados, in our geographic markets; and increased competition from both banks and non-banks. The foregoing list of factors is not exhaustive. For discussion of these and other risks that may cause actual results to differ from expectations, please refer to “Cautionary Note Regarding Forward Looking Statements” and “Risk Factors” in our most recent Annual Report on Form 10-K/A and our other SEC filings. If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained herein. Accordingly, you should not place undue reliance on any forward-looking statements, which speak only as of the date made. ServisFirst Bancshares, Inc. assumes no obligation to update or revise any forward-looking statements that are made from time to time.
Business
We are a bank holding company under the Bank Holding Company Act of 1956 and are headquartered in Birmingham, Alabama. Our wholly-owned subsidiary, ServisFirst Bank, an Alabama banking corporation, provides commercial banking services through thirteen full-service banking offices located in Alabama and the panhandle of Florida, as well as a loan production office in Nashville, Tennessee. Through the Bank, we originate commercial, consumer and other loans and accept deposits, provide electronic banking services, such as online and mobile banking, including remote deposit capture, deliver treasury and cash management services and provide correspondent banking services to other financial institutions.
Our principal business is to accept deposits from the public and to make loans and other investments. Our principal sources of funds for loans and investments are demand, time, savings, and other deposits (including negotiable orders of withdrawal, or NOW accounts). Our principal sources of income are interest and fees collected on loans, interest and dividends collected on other investments and service charges. Our principal expenses are interest paid on savings and other deposits (including NOW accounts), interest paid on our other borrowings, employee compensation, office expenses, other overhead expenses and income taxes.
Overview
As of September 30, 2014, we had consolidated total assets of $4.0 billion, an increase of $0.5 billion, or 14.3%, from $3.5 billion at December 31, 2013. Total loans were $3.2 billion at September 30, 2014, up $0.3 billion, or 10.3%, from $2.9 billion at December 31, 2013. Total deposits were $3.4 billion at September 30, 2014, an increase of $0.4 billion, or 13.3%, from $3.0 billion at December 31, 2013.
Net income available to common stockholders for the quarter ended September 30, 2014 was $13.9 million, an increase of $3.2 million, or 29.9%, from $10.7 million for the quarter ended September 30, 2013. Basic and diluted earnings per common share were $0.56 and $0.54, respectively, for the three months ended September 30, 2014, compared to $0.51 and $0.49, respectively, for the corresponding period in 2013.
Net income available to common stockholders for the nine months ended September 30, 2014 was $37.0 million, an increase of $7.6 million, or 25.9%, from $29.4 million for the nine months ended September 30, 2013. Basic and diluted earnings per common share were $1.57 and $1.51, respectively, for the nine months ended September 30, 2014, compared to $1.45 and $1.37, respectively, for the corresponding period in 2013.
The Company completed an initial public offering of 1,875,000 shares of its common stock during the quarter ended June 30, 2014, generating gross proceeds of $56.9 million to support future growth. Stockholders’ equity increased to $393.1 million at September 30, 2014, or 32.3%, from $297.2 million at December 31, 2013. The increase was primarily attributable to the results of the Company’s initial public offering and retained earnings over the period.
Critical Accounting Policies
The accounting and financial policies of the Company conform to U.S. generally accepted accounting principles (“U.S. GAAP”) and to general practices within the banking industry. To prepare consolidated financial statements in conformity with U.S. GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, valuation of foreclosed real estate, deferred taxes, and fair value of financial instruments are particularly subject to change. Information concerning our accounting policies with respect to these items is available in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013.
Financial Condition
Cash and Cash Equivalents
At September 30, 2014, we had $6.6 million in federal funds sold, compared to $8.6 million at December 31, 2013. We also maintain balances at the Federal Reserve Bank of Atlanta, which earn interest. At September 30, 2014, we had $276.6 million in balances at the Federal Reserve, compared to $186.0 million at December 31, 2013.
Debt Securities
Debt securities available for sale totaled $302.3 million at September 30, 2014 and $266.2 million at December 31, 2013. Debt securities held to maturity totaled $30.0 million at September 30, 2014 and $32.3 million at December 31, 2013. Pay-downs of $16.4 million in mortgage-backed securities, and maturities and calls of $9.6 million in government agency and municipal securities were replaced with purchases of $11.5 million of U.S. Treasury securities, $25.5 million of mortgage-backed securities, $7.8 million of U.S. government agencies and $14.5 million of municipal securities during the first nine months of 2014. All securities bought during the first nine months of 2014 are classified as available for sale.
The objective of our investment policy is to invest funds not otherwise needed to meet our loan demand to earn the maximum return, yet still maintain sufficient liquidity to meet fluctuations in our loan demand and deposit structure. In doing so, we balance the market and credit risks against the potential investment return, make investments compatible with the pledge requirements of any deposits of public funds, maintain compliance with regulatory investment requirements, and assist certain public entities with their financial needs. The investment committee has full authority over the investment portfolio and makes decisions on purchases and sales of securities. The entire portfolio, along with all investment transactions occurring since the previous board of directors meeting, is reviewed by the board at each monthly meeting. The investment policy allows portfolio holdings to include short-term securities purchased to provide us with needed liquidity and longer term securities purchased to generate level income for us over periods of interest rate fluctuations.
Each quarter, management assesses whether there have been events or economic circumstances indicating that a security on which there is an unrealized loss is other-than-temporarily impaired. Management considers several factors, including the amount and duration of the impairment; the intent and ability of the Company to hold the security for a period sufficient for a recovery in value; and known recent events specific to the issuer or its industry. In analyzing an issuer’s financial condition, management considers whether the securities are issued by agencies of the federal government, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports, among other things. As we currently do not have the intent to sell these securities and it is not more likely than not that we will be required to sell these securities before recovery of their amortized cost basis, which may be at maturity, and impairment positions at September 30, 2014 are interest-rate driven, no declines are deemed to be other than temporary. We will continue to evaluate our investment securities for possible other-than-temporary impairment, which could result in non-cash charges to earnings in one or more future periods.
All securities held are traded in liquid markets. As of September 30, 2014, we owned certain restricted securities of the Federal Home Loan Bank with an aggregate book value and market value of $3.2 million and certain securities of First National Bankers Bank in which we invested $0.3 million. We had no investments in any one security, restricted or liquid, in excess of 10% of our stockholders’ equity.
The Bank does not invest in collateralized debt obligations (“CDOs”). All tax-exempt securities currently held are issued by government issuers within the State of Alabama. All corporate bonds had a Standard and Poor’s or Moody’s rating of A-1 or better when purchased. The total investment portfolio at September 30, 2014 has a combined average credit rating of AA.
The carrying value of investment securities pledged to secure public funds on deposit and for other purposes as required by law was $218.3 million and $200.7 million as of September 30, 2014 and December 31, 2013, respectively.
Loans
We had total loans of $3.2 billion at September 30, 2014, an increase of $0.3 billion, or 10.3%, compared to $2.9 billion at December 31, 2013. At September 30, 2014, the percentage of our loans in each of our markets were as follows:
Asset Quality
The allowance for loan losses is established and maintained at levels management deems adequate to absorb anticipated credit losses from identified and otherwise inherent risks in the loan portfolio as of the balance sheet date. In assessing the adequacy of the allowance for loan losses, management considers its evaluation of the loan portfolio, past due loan experience, collateral values, current economic conditions and other factors considered necessary to maintain the allowance at an adequate level. Our management believes that the allowance was adequate at September 30, 2014.
The following table presents the allocation of the allowance for loan losses for each respective loan category with the corresponding percentage of loans in each category to total loans. Management believes that the comprehensive allowance analysis developed by our credit administration group is in compliance with all current regulatory guidelines.
Nonperforming Assets
Total nonperforming loans, which include nonaccrual loans and loans 90 or more days past due and still accruing, increased to $17.3 million at September 30, 2014, compared to $9.7 million at December 31, 2013. Of this total, nonaccrual loans of $16.1 million at September 30, 2014 represented a net increase of $6.5 million from nonaccrual loans at December 31, 2013. The majority of this increase is attributable to one loan totaling $4.3 million being placed on nonaccrual status during the third quarter of 2014. There were three loans 90 or more days past due and still accruing totaling $1.2 million at September 30, 2014, compared to two loans 90 or more days past due and still accruing totaling $115,000, at December 31, 2013. Troubled Debt Restructurings (“TDR”) at September 30, 2014 and December 31, 2013 were $7.9 million and $14.2 million, respectively. This decrease is attributable to net pay-downs of $5.7 million and net charge-offs of $2.0 million during 2014. One loan totaling $1.4 million was newly classified as a TDR and occurred during the second quarter of 2014.
Other real estate owned (OREO) and repossessed assets decreased to $6.9 million at September 30, 2014, from $12.9 million at December 31, 2013. The total number of OREO and repossessed asset accounts decreased to 25 at September 30, 2014, from 51 at December 31, 2013. The following table summarizes OREO and repossessed asset activity for the nine months ended September 30, 2014 and 2013:
The following table summarizes our nonperforming assets and TDRs at September 30, 2014 and December 31, 2013:
The balance of nonperforming assets can fluctuate due to changes in economic conditions. We have established a policy to discontinue accruing interest on a loan (i.e., place the loan on nonaccrual status) after it has become 90 days delinquent as to payment of principal or interest, unless the loan is considered to be well-collateralized and is actively in the process of collection. In addition, a loan will be placed on nonaccrual status before it becomes 90 days delinquent unless management believes that the collection of interest is expected. Interest previously accrued but uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. Interest income on nonaccrual loans is recognized only as received. If we believe that a loan will not be collected in full, we will increase the allowance for loan losses to reflect management’s estimate of any potential exposure or loss. Generally, payments received on nonaccrual loans are applied directly to principal.
Impaired Loans and Allowance for Loan Losses
We have allocated approximately $6.7 million of our allowance for loan losses to real estate construction, including acquisition and development and lot loans, $14.5 million to commercial, financial and agricultural loans and $13.2 million to other loan types. The total resulting loan loss reserve is $34.4 million. Based upon historical performance, known factors, overall judgment and regulatory methodologies, including consideration of the possible effect of current residential housing market defaults and business failures plaguing financial institutions in general, management believes that the current methodology used to determine the adequacy of the allowance for loan losses is reasonable.
As of September 30, 2014, we had impaired loans of $26.7 million inclusive of nonaccrual loans, a decrease of $5.3 million from $32.0 million as of December 31, 2013. We allocated $6.3 million of our allowance for loan losses at September 30, 2014 to these impaired loans. A loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the original loan agreement. Impairment does not always indicate credit loss, but provides an indication of collateral exposure based on prevailing market conditions and third-party valuations. Impaired loans are measured by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent. The amount of impairment, if any, and subsequent changes are included in the allowance for loan losses. Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status. Our credit risk management team performs verification and testing to ensure appropriate identification of impaired loans and that proper reserves are held on these loans.
Of the $26.7 million of impaired loans reported as of September 30, 2014, $7.8 million were real estate construction, of which $6 million (a total of 13 loans with 4 builders) were residential construction loans. $14.6 million were real estate mortgage loans, $3.6 million were commercial, financial and agricultural loans, and $0.7 million were consumer loans.
Deposits
Total deposits increased $0.4 billion, or 13.3%, to $3.4 billion at September 30, 2014 compared to $3.0 billion at December 31, 2013. We anticipate long-term sustainable growth in deposits through continued development of market share in our markets.
For amounts and rates of our deposits by category, see the table “Average Consolidated Balance Sheets and Net Interest Analysis on a Fully Taxable-equivalent Basis” under the subheading “Net Interest Income.”
Other Borrowings
Our borrowings consist of federal funds purchased and subordinated notes payable. We had $178.2 million and $174.4 million at September 30, 2014 and December 31, 2013, respectively, in federal funds purchased from correspondent banks that are clients of our correspondent banking unit. The average rate paid on these borrowings was 0.28% for the quarter ended September 30, 2014. The $20.0 million in other borrowings consist of 5.50% Subordinated Notes due November 9, 2022, which were issued in a private placement in November 2012. The notes pay interest semi-annually.
Liquidity
Liquidity is defined as our ability to generate sufficient cash to fund current loan demand, deposit withdrawals, and other cash demands and disbursement needs, and otherwise to operate on an ongoing basis.
The retention of existing deposits and attraction of new deposit sources through new and existing customers is critical to our liquidity position. If our liquidity were to decline due to a run-off in deposits, we have procedures that provide for certain actions under varying liquidity conditions. These actions include borrowing from existing correspondent banks, selling or participating loans, and curtailing loan commitments and funding. At September 30, 2014, liquid assets, which are represented by cash and due from banks, federal funds sold and unpledged available-for-sale securities, totaled $131.4 million. Additionally, the Bank had additional borrowing availability of approximately $160.0 million in unused federal funds lines of credit with regional banks, subject to certain restrictions and collateral requirements. We added a new line for $40.0 million during the second quarter of 2014. We believe these sources of funding are adequate to meet immediate anticipated funding needs. Our management meets on a quarterly basis to review sources and uses of funding to determine the appropriate strategy to ensure an appropriate level of liquidity. At the current time, our long-term liquidity needs primarily relate to funds required to support loan originations and commitments and deposit withdrawals. Our regular sources of funding are from the growth of our deposit base, correspondent banking relationships and related federal funds purchased, repayment of principal and interest on loans, the sale of loans and the renewal of time deposits. In addition, we have issued debt as described above under “Other Borrowings”.
We are subject to general FDIC guidelines that require a minimum level of liquidity. Management believes our liquidity ratios meet or exceed these guidelines. Our management is not currently aware of any trends or demands that are reasonably likely to result in liquidity materially increasing or decreasing.
The following table reflects the contractual maturities of our term liabilities as of September 30, 2014. The amounts shown do not reflect any early withdrawal or prepayment assumptions.
(1) Excludes interest
(2) Certificates of deposit give customers the right to early withdrawal. Early withdrawals may be subject to penalties.
The penalty amount depends on the remaining time to maturity at the time of early withdrawal.
Capital Adequacy
As of September 30, 2014, our most recent notification from the FDIC categorized us as well-capitalized under the regulatory framework for prompt corrective action. To remain categorized as well-capitalized, we must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as disclosed in the table below. Our management believes that we are well-capitalized under the prompt corrective action provisions as of September 30, 2014.
The following table sets forth (i) the capital ratios required by the FDIC and the Alabama Banking Department’s leverage ratio requirement and (ii) our actual ratios of capital to total regulatory or risk-weighted assets, as of September 30, 2014, December 31, 2013 and September 30, 2013:
Off-Balance Sheet Arrangements
As part of our mortgage operations, we originate and sell certain loans to investors in the secondary market. We continue to experience a manageable level of investor repurchase demands. For loans sold, we have an obligation to either repurchase the outstanding principal balance of a loan or make the purchaser whole for the economic benefits of a loan if it is determined that the loans sold were in violation of representations and warranties made by the Bank at the time of the sale. Representations and warranties typically include those made regarding loans that had missing or insufficient file documentation or loans obtained through fraud by borrowers or other third parties such as appraisers. We had a reserve of $308,000 as of September 30, 2014 and $264,000 as of December 31, 2013 for the settlement of any repurchase demands by investors.
Financial instruments whose contract amounts represent credit risk at September 30, 2014 are as follows:
Commitments to extend credit beyond current funded amounts are agreements to lend to a customer as long as there is no violation of any condition established in the applicable loan agreement. Such commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by us upon extension of credit is based on our management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. All letters of credit are due within one year or less of the original commitment date. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Federal funds lines of credit are uncommitted lines issued to downstream correspondent banks for the purpose of providing liquidity to them. The lines are unsecured, and we have no obligation to sell federal funds to the correspondent, nor does the correspondent have any obligation to request or accept purchases of federal funds from us.
Results of Operations
Summary of Net Income
Net income for the three months ended September 30, 2014 was $14.0 million compared to net income of $10.8 million for the three months ended September 30, 2013. Net income for the nine months ended September 30, 2014 was $37.3 million compared to net income of $29.7 million for the nine months ended September 30, 2013. Core net income for the nine months ended September 30, 2014 was $39.0 million. Core net income excludes the impact of non-routine expenses in the first and second quarter of 2014 resulting from the correction of our accounting for vested stock options previously granted to members of our advisory boards in our markets, including the acceleration of vesting, as more fully described in “Non-interest Expense” below. For a reconciliation of these non-GAAP measures to the most comparable GAAP measure, see “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” below. Increases in net income were primarily attributable to increased net interest income, partially offset by increased operating expenses. Net interest income for the three months ended September 30, 2014 increased to $33.3 million, or 14.8%, compared to $29.0 million for the corresponding period in 2013. Net interest income for the nine months ended September 30, 2014 increased to $96.1 million, or 16.8%, compared to $82.3 million for the corresponding period in 2013. The provision for loan losses decreased $0.3 million to $2.7 million for the three months ended September 30, 2014 compared to the corresponding period in 2013, and decreased $3.2 million to $7.5 million for the nine months ended September 30, 2014 compared to the corresponding period in 2013. The decrease in provision for loan losses is more fully explained in “Provision for Loan Losses” below. Non-interest income increased $0.7 million to $3.0 million for the three months ended September 30, 2014 compared to the corresponding period in 2013, and increased $0.5 million to $8.1 million for the nine months ended September 30, 2014 compared to the corresponding period in 2013. Non-interest expenses for the three months ended September 30, 2014 increased $3.2 million, or 26.4%, to $15.3 million, compared to $12.1 million for the corresponding period in 2013, and for the nine months ended September 30, 2014 increased $9.3 million, or 26.4%, to $44.5 million compared to $35.2 million for the corresponding period in 2013. Changes in non-interest income and non-interest expense are more fully explained below.
Basic and diluted net income per common share were $0.56 and $0.54, respectively, for the three months ended September 30, 2014, compared to $0.51 and $0.49, respectively, for the corresponding period in 2013. Basic and diluted net income per common share were $1.57 and $1.51, respectively, for the nine months ended September 30, 2014, compared to $1.45 and $1.37, respectively, for the corresponding period in 2013. Core basic and diluted earnings per share were $1.64 and $1.57, respectively, for the nine months ended September 30, 2014. Return on average assets for the three and nine months ended September 30, 2014 was 1.45% and 1.37%, respectively, compared to 1.31% for both of the corresponding periods in 2013. Core return on average assets for the nine months ended September 30, 2014 was 1.43%. Return on average common stockholders’ equity for the three and nine months ended September 30, 2014 was 15.89% and 16.17%, respectively, compared to 18.47% and 18.34% for the corresponding period in 2013. Core return on average common stockholders’ equity for the nine months ended September 30, 2014 was 16.88%.
Net Interest Income
Net interest income is the difference between the income earned on interest-earning assets and interest paid on interest-bearing liabilities used to support such assets. The major factors which affect net interest income are changes in volumes, the yield on interest-earning assets and the cost of interest-bearing liabilities. Our management’s ability to respond to changes in interest rates by effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of our primary source of earnings.
Taxable-equivalent net interest income increased $4.4 million, or 15.1%, to $33.8 million for the three months ended September 30, 2014 compared to $29.4 million for the corresponding period in 2013, and increased $14.0 million, or 16.8%, to $97.5 million for the nine months ended September 30, 2014 compared to $83.5 million for the corresponding period in 2013. This increase was primarily attributable to growth in average earning assets, which increased $0.5 billion, or 16.4%, from the third quarter of 2013 to the third quarter of 2014, and $0.6 billion, or 20.3%, from the nine months ended September 30, 2013 to the same period in 2014. The taxable-equivalent yield on interest-earning assets decreased to 4.03% for the three months ended September 30, 2014 from 4.14% for the corresponding period in 2013, and decreased to 4.12% for the nine months ended September 30, 2014 from 4.30% for the corresponding period in 2013. The yield on loans for the three months ended September 30, 2014 was 4.44% compared to 4.56% for the corresponding period in 2013, and 4.47% compared to 4.59% for the nine months ended September 30, 2014 and September 30, 2013, respectively. Loan fees included in the yield calculation increased to $238,000 for the three months ended September 30, 2014 from $176,000 for the corresponding period in 2013, and increased to $698,000 for the nine months ended September 30, 2014 from $241,000 for the corresponding period in 2013. Document preparation fees charged on each loan were increased from $300 to $400 early in 2014, and there was an increase in the amount of letter of credit fees collected during the three and nine months ended September 30, 2014 when compared to the same periods in 2013. The cost of total interest-bearing liabilities decreased to 0.53% for the three months ended September 30, 2014 from 0.58% for the corresponding period in 2013, and to 0.53% for the nine months ended September 30, 2014 from 0.60% for the corresponding period in 2013. Net interest margin for the three months ended September 30, 2014 was 3.65% compared to 3.69% for the corresponding period in 2013, and 3.72% for the nine months ended September 30, 2014 compared to 3.84% for the corresponding period in 2013.
The following tables show, for the three and nine months ended September 30, 2014 and September 30, 2013, the average balances of each principal category of our assets, liabilities and stockholders’ equity, and an analysis of net interest revenue. The accompanying tables reflect changes in our net interest margin as a result of changes in the volume and rate of our interest-earning assets and interest-bearing liabilities for the same periods. Changes as a result of mix or the number of days in the periods have been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. The tables are presented on a taxable-equivalent basis where applicable:
Average Consolidated Balance Sheets and Net Interest Analysis
On a Fully Taxable-Equivalent Basis
For the Three Months Ended September 30, 2014 and 2013
(Dollar Amounts In Thousands)
We have experienced an unfavorable variance relating to the interest rate component because rates on earning assets have declined at a greater pace compared to deposit cost. Accordingly, the prolonged low interest rate environment has resulted in a compression of the net interest margin. Our growth in loans continues to result in favorable volume component change and overall change.
For the Nine Months Ended September 30, 2014 and 2013
The prolonged low interest rate environment has led to net interest margin compression and the net interest margin declined by four basis points in the comparable 2014 period. Our growth in loans continues to result in a favorable volume component change and overall change.
Provision for Loan Losses
The provision for loan losses represents the amount determined by management to be necessary to maintain the allowance for loan losses at a level capable of absorbing inherent losses in the loan portfolio. Our management reviews the adequacy of the allowance for loan losses on a quarterly basis. The allowance for loan losses calculation is segregated into various segments that include classified loans, loans with specific allocations and pass rated loans. A pass rated loan is generally characterized by a very low to average risk of default and in which management perceives there is a minimal risk of loss. Loans are rated using a nine-point risk grade scale with loan officers having the primary responsibility for assigning risk grades and for the timely reporting of changes in the risk grades. Based on these processes, and the assigned risk grades, the criticized and classified loans in the portfolio are segregated into the following regulatory classifications: Special Mention, Substandard, Doubtful or Loss, with some general allocation of reserve based on these grades. At September 30, 2014, total loans rated Special Mention, Substandard, and Doubtful were $76.7 million, or 2.4% of total loans, compared to $93.2 million, or 3.3% of total loans, at December 31, 2013. Impaired loans are reviewed specifically and separately under FASB ASC 310-30-35, Subsequent Measurement of Impaired Loans, to determine the appropriate reserve allocation. Our management compares the investment in an impaired loan with the present value of expected future cash flow discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral-dependent, to determine the specific reserve allowance. Reserve percentages assigned to non-impaired loans are based on historical charge-off experience adjusted for other risk factors. To evaluate the overall adequacy of the allowance to absorb losses inherent in our loan portfolio, our management considers historical loss experience based on volume and types of loans, trends in classifications, volume and trends in delinquencies and nonaccruals, economic conditions and other pertinent information. Based on future evaluations, additional provisions for loan losses may be necessary to maintain the allowance for loan losses at an appropriate level.
The provision for loan losses was $2.7 million for the three months ended September 30, 2014, a decrease of $0.3 million from $3.0 million for the three months ended September 30, 2013, and was $7.5 million for the nine months ended September 30, 2014, a $3.2 million decrease, compared to $10.7 million for the nine months ended September 30, 2013. The decrease in provision for loan losses for the three and nine month periods ended September 30, 2014 is primarily attributable to improving credit quality resulting from fewer loan charge-offs. Annualized net charge-offs to average loans were 0.17% for each of the three and nine months ended September 30, 2014 compared to 0.43% and 0.42% for the three and nine months ended September 30, 2013. Nonperforming loans increased to $17.3 million, or 0.55% of total loans, at September 30, 2014 from $9.7 million, or 0.34% of total loans, at December 31, 2013, and were also higher than $9.4 million, or 0.34% of total loans, at September 30, 2013. Impaired loans decreased to $26.7 million, or 0.85% of total loans, at September 30, 2014, compared to $32.0 million, or 1.1% of total loans, at December 31, 2013. The allowance for loan losses totaled $34.4 million, or 1.09% of total loans, net of unearned income, at September 30, 2014, compared to $30.7 million, or 1.07% of loans, net of unearned income, at December 31, 2013 and $28.9 million, or 1.06%of loans, net of unearned income, at September 30, 2013.
Non-interest Income
Non-interest income totaled $3.0 million for the three months ended September 30, 2014, an increase of $0.7 million, or 30.4%, compared to the corresponding period in 2013, and totaled $8.1 million for the nine months ended September 30, 2014, an increase of $0.5 million, or 6.6%, compared to the corresponding period in 2013. Service charges on deposit accounts increased to $1.2 million for the three months ended September 30, 2014 compared to $0.8 million for the same period in 2013, and increased to $3.1 million for the nine months ended September 30, 2014 compared to $2.4 million for the same period in 2013. This increase was primarily the result of increases in monthly service charges and various transaction fees on many of our business account types that became effective in May 2014. Income from credit cards increased to $0.5 million for the three months ended September 30, 2014 from $0.4 million for the same period in 2013, and increased to $1.5 million for the nine months ended September 30, 2014 compared to $1.0 million for the same period in 2013. We continue to aggressively expand our credit card products, and have begun to sell credit card services through our correspondent banks. Increases in the cash surrender value of bank-owned life insurance contracts increased by $0.2 million during the nine month period ended September 30, 2014 compared to the same period in 2013, a result of the purchase of additional life insurance contracts in September 2013. Income from mortgage banking for the three months ended September 30, 2014 was $0.6 million, up from $0.4 million for the same period in 2013, and for the nine months ended September 30, 2014 was $1.5 million compared to $2.2 million for the same period in 2013. Recent fluctuations in market rates for mortgages have resulted in a lower number of refinancings of existing mortgages. We sold one debt security during the first nine months of 2014 with a very small gain compared to $0.1 million in gains on sales proceeds of $4.1 million during the first nine months of 2013.
Non-interest Expense
Non-interest expense totaled $15.3 million for the three months ended September 30, 2014, an increase of $3.2 million, or 26.4%, compared to $12.1 million for the same period in 2013, and totaled $44.5 million for the nine months ended September 30, 2014, an increase of $9.3 million, or 26.4%, compared to $35.2 million for the same period in 2013.
Details of expenses are as follows:
The following table presents our non-interest income and non-interest expense for the three and nine month periods ending September 30, 2014 compared to the same periods in 2013.
Income Tax Expense
Income tax expense was $4.3 million for the three months ended September 30, 2014 compared to $5.3 million for the same period in 2013, and was $15.0 million for the nine months ended September 30, 2014 compared to $14.4 million for the same period in 2013. Our effective tax rate for the three and nine months ended September 30, 2014 was 23.3% and 28.6%, respectively, compared to 33.0% and 32.6%, respectively, for the corresponding periods in 2013. The decrease in the effective rate of the 2014 periods primarily relates to historic rehabilitation tax credits. Our primary permanent differences are related to tax exempt income on securities, state income tax benefit on real estate investment trust dividends, various qualifying tax credits, change in cash surrender value of bank-owned life insurance and incentive stock option expenses.
We own real estate investment trusts for the purpose of holding and managing participations in residential mortgages and commercial real estate loans originated by the Bank. The trusts are majority-owned subsidiaries of a trust holding company, which in turn is a wholly-owned subsidiary of the Bank. The trusts earn interest income on the loans they hold and incur operating expenses related to their activities. They pay their net earnings, in the form of dividends, to the Bank, which receives a deduction for state income taxes.
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
As discussed in more detail in the section titled “Non-interest Expense,” we recorded a non-routine expense of $0.7 million for the first quarter of 2014 resulting from the correction of our accounting for vested stock options previously granted to members of our advisory boards, and we recorded a non-routine expense of $1.8 million for the second quarter of 2014 resulting from an acceleration of vesting of stock options previously granted to members of our advisory boards. This change in accounting treatment is a non-cash item and does not impact our operating activities or cash from operations. The non-GAAP financial measures included in this quarterly report on Form 10-Q results for the nine months ended September 30, 2014 are “core net income,” “core net income available to common stockholders,” “core diluted earnings per share,” “core return on average assets” and “core return on average common stockholders’ equity.” Each of these five core financial measures excludes the impact of the non-routine expenses attributable to the correction of our accounting for stock options and related acceleration of vesting of such stock options.
“Core net income” is defined as net income, adjusted by the net effect of the non-routine expense.
“Core net income available to common stockholders” is defined as net income available to common stockholders, adjusted by the net effect of the non-routine expense.
“Core diluted earnings per share” is defined as net income available to common stockholders, adjusted by the net effect of the non-routine expense, divided by weighted average diluted shares outstanding.
“Core return on average assets” is defined as net income, adjusted by the net effect of the non-routine expense, divided by average total assets.
“Core return of average common stockholders’ equity” is defined as net income, adjusted by the net effect of the non-routine expense, divided by average common stockholders’ equity.
We believe these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that these non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies, including those in our industry, use. The following reconciliation table provides a more detailed analysis of the non-GAAP financial measures for the nine months ended September 30, 2014. Dollars are in thousands, except share and per share data.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Like all financial institutions, we are subject to market risk from changes in interest rates. Interest rate risk is inherent in the balance sheet due to the mismatch between the maturities of rate-sensitive assets and rate-sensitive liabilities. If rates are rising, and the level of rate-sensitive liabilities exceeds the level of rate-sensitive assets, the net interest margin will be negatively impacted. Conversely, if rates are falling, and the level of rate-sensitive liabilities is greater than the level of rate-sensitive assets, the impact on the net interest margin will be favorable. Managing interest rate risk is further complicated by the fact that all rates do not change at the same pace; in other words, short-term rates may be rising while longer-term rates remain stable. In addition, different types of rate-sensitive assets and rate-sensitive liabilities react differently to changes in rates.
To manage interest rate risk, we must take a position on the expected future trend of interest rates. Rates may rise, fall or remain the same. Our asset-liability committee develops its view of future rate trends and strives to manage rate risk within a targeted range by monitoring economic indicators, examining the views of economists and other experts, and understanding the current status of our balance sheet. Our annual budget reflects the anticipated rate environment for the next 12 months. The asset-liability committee conducts a quarterly analysis of the rate sensitivity position and reports its results to our board of directors.
The asset-liability committee thoroughly analyzes the maturities of rate-sensitive assets and liabilities. This analysis measures the “gap”, which is defined as the difference between the dollar amount of rate-sensitive assets repricing during a period and the volume of rate-sensitive liabilities repricing during the same period. The gap is also expressed as the ratio of rate-sensitive assets divided by rate-sensitive liabilities. If the ratio is greater than one, the dollar value of assets exceeds the dollar value of liabilities; the balance sheet is “asset-sensitive.” Conversely, if the value of liabilities exceeds the value of assets, the ratio is less than one and the balance sheet is “liability-sensitive.” Our internal policy requires management to maintain the gap such that net interest margins will not change more than 10% if interest rates change 100 basis points or more than 15% if interest rates change 200 basis points. There have been no changes to our policies or procedures for analyzing our interest rate risk since December 31, 2013, and there are no significant changes to our sensitivity to changes in interest rates since December 31, 2013 as disclosed in our Form 10-K/A.
ITEM 4. CONTROLS AND PROCEDURES
CEO and CFO Certification.
Appearing as exhibits to this report are Certifications of our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”). The Certifications are required to be made by Rule 13a-14 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This item contains the information about the evaluation that is referred to in the Certifications, and the information set forth below in this Item 4 should be read in conjunction with the Certifications for a more complete understanding of the Certifications.
Evaluation of Disclosure Controls and Procedures.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
We conducted an evaluation (the "Evaluation") of the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of our management, including our CEO and CFO, as of September 30, 2014. Based upon the Evaluation, our CEO and CFO have concluded that, as of September 30, 2014, our disclosure controls and procedures are effective to ensure that material information relating to ServisFirst Bancshares, Inc. and its subsidiaries is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared.
There have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except as previously disclosed in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time we may be a party to various legal proceedings arising in the ordinary course of business. We are not currently a party to any material legal proceedings except as disclosed in Item 3, “Legal Proceedings”, in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013, and there has been no material change in any matter described therein.
ITEM 1A. RISK FACTORS
Our business is influenced by many factors that are difficult to predict, involve uncertainties that may materially affect actual results and are often beyond our control. We have identified a number of these risk factors in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013, which should be taken into consideration when reviewing the information contained in this report. There have been no material changes with regard to the risk factors previously disclosed in the Form 10-K/A. For other factors that may cause actual results to differ materially from those indicated in any forward-looking statement or projection contained in this report, see “Forward-Looking Statements” under Part 1, Item 2 above.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On May 13, 2014, the Company’s registration statement on Form S-1 (File No. 333-193401), which related to the Company’s initial public offering, was declared effective by the SEC. Under that registration statement, the Company registered and sold an aggregate of 1,875,000 shares of common stock at a price to the public of $30.33 per share, generating gross offering proceeds of approximately $56.9 million. The net proceeds to the Company of the sale of such shares, after underwriting commissions and offering expenses, were approximately $52.1 million. There has been no material change in the planned use of proceeds from the Company’s initial public offering as described in its final prospectus filed with the SEC on May 14, 2014 under Rule 424(b) of the Securities Act of 1933, as amended. Through October 29, 2014, the Company has not applied any of the proceeds.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Thomas A. Broughton III
William M. Foshee